Diversification is key to ensuring you will be able to take advantage of every opportunity without incurring too much risk.
If youâ€™re paying attention to developments in the cryptocurrency space, youâ€™ve likely heard of decentralized finance and of the yield farming trend that helped itÂ get over $9 billion worth of crypto assetsÂ locked in it.
In short, yield farming â€” also known as liquidity mining â€” sees users generate rewards with their cryptocurrency holdings by interacting with DeFi protocols that either let them lend or borrow tokens. These interactions grant them the protocolsâ€™ governance tokens, which both give them a â€œstakeâ€ in the protocol and more revenue.
The trend started when lending protocolÂ Compound started distributing its COMP governance token. Shortly after, various other protocols launched their own governance tokens and distributed them in the same way. Now protocols such as Yearn.finance act like smart savings accounts, helping users find the best yields across the DeFi space while rewarding them with YFI tokens.
The appeal of DeFi
Ever since Compound launched its governance token, the total value locked in the DeFi space surged, as users started moving to farm yield as quickly as possible. With rewards generated from the tokens being distributed, annual percentage yields can often exceed 1,000%.
With 10-year treasury yieldsÂ beingÂ at 0.6% and 12-month yields at 0.09%, 1,000% is an extremely attractive offer. Users can lend stablecoins on DeFi protocols, so the risks appear to be next to none: If the tokens they are farming lose value, theyâ€™re still earning rewards for lending funds, and these rewards are well above 0.67% on most platforms.
There are, however, hidden risks associated with DeFi and yield farming. Popular DeFi protocols are developed by small teams with limited resources, which can increase the risk of smart contract bugs and vulnerabilities.Â Even well-known audited protocols have been hacked.
Moreover, scammers take advantage of every opportunity in crypto, andÂ multiple cases of exit scamsÂ and outright fraudulent projects in DeFi have already been reported. While there are opportunities to make a lot of money in this space, there are also hidden dangers that investors need to watch out for.
How centralized finance can help?
As weâ€™ve seen before, if you are investing in the DeFi space, itâ€™s always better to bet on diversification instead of short-term gains. A DeFi portfolio should have exposure to top cryptocurrencies in the space, ensuring you donâ€™t lose everything to scams, unexpected market moves or technical issues, and invest in potential gems while itâ€™s still early.
Diversification ensures a sustainable approach to gain exposure to the wonders of DeFi while ensuring you donâ€™t lose all your money to a bug or human error.
True decentralization is seen as a strength in crypto, and we can use decentralization to our advantage in investing in DeFi and yield farming. Thereâ€™s no doubt that the best returns are on the protocols that distribute tokens, but using them is also as risky as it gets.
As such, a novel investing approach would be to set part of your funds to farm yield on a centralized exchange. Itâ€™s more secure and stable, but the rewards arenâ€™t going to be as wild. For wilder rewards, using a Web 3.0-compatible wallet and testing out new protocols are the way to go. Every farmer should have a different approach, just like every investor diversifies their portfolio among stocks, commodities and bonds.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, readers should conduct their own research when making a decision.